If you have a credit card, you’ll be issued a statement every month. While some people will look at their posted transaction details, most people will only pay attention to the statement balance since that’s the total amount due. That said, listed right by the statement balance is the minimum balance requirement. This number can change every month, which leaves many to wonder, how is a credit card minimum payment calculated?
What is the minimum payment?
As the name implies, the minimum payment is the minimum payment you’re required to make each month to your credit card provider. As long as you make this payment, your credit card provider will view it as a payment made. This is essential since missing two payments in a row can greatly affect your credit score.
How minimum payments are calculated
You can quickly find out how your minimum balance is calculated by referring to your cardholder agreement. Don’t worry if you threw it out, as the most updated agreement can be found online. Typically, credit card providers will use one of the following formulas to determine your minimum payment:
Every credit card applies a flat percentage to determine your minimum payment. This is typically between 2% and 5%. The percentage you pay is determined by your credit card provider and your individual credit card.
For example, let’s say your credit card billing cycle has ended, and you have a balance of $2,000. Your credit card provider calculates the minimum payment based on 3% of your balance. That means your minimum payment would be $60.
Percentage + interest + fees
If you’re currently carrying a balance and have incurred interest charges or additional fees, your credit card may add those amounts to the standard monthly percentage to calculate your minimum payment.
For example, let’s say you have a credit card balance of $5,000 that uses a 3% minimum payment structure. That means your minimum payment would be $150. However, you have outstanding interest charges of $100 and you incurred a cash advance fee of $25. In this situation, your minimum payment would be $275.
In most cases, credit cards will also have a flat rate for the minimum payment. This would only apply when the flat percentage is lower than the flat rate.
For example, let’s say your credit card charges a 2% flat percentage, or $10, whichever is higher for the minimum payment. If your statement balance is $100, then your minimum payment would be $10. That’s because the flat percentage rate would be $2, which falls below the minimum threshold of $10.
The final calculation used to determine your minimum payment is the entire amount. This number would come into play when your total charges fall below the minimum flat rate.
For example, let’s say your credit card has a minimum payment of $25, but you only charged $15 to your card for the month. In this case, your minimum amount would be the entire balance.
How does making the minimum payment affect my credit?
While making the minimum payment on your credit card will ensure you don’t have a missed or late payment, it can still affect your credit score. That’s because your credit utilization ratio plays a major factor in determining your credit score.
Your credit utilization ratio is the amount of credit you’re using relative to how much total credit you have available. For example, let’s say you have a credit card limit of $5,000 and you currently have a balance of $4,000 since you’ve been making only the minimum payments. That’s a credit utilization ratio of 80%
Equifax and TransUnion – the two credit bureaus – prefer you keep your credit utilization ratio under 30%. If you were to pay down your balance, you would lower your credit utilization ratio. This could potentially improve your credit score.
Is it better to pay more than the minimum balance?
Even though paying the minimum balance can help you manage your cash flow and keep your credit card provider happy, it’s always in your best interest to pay your entire balance in full. That’s because the amount of interest you’ll pay can be costly.
Most credit cards in Canada charge an interest rate of 20% to 24%. That’s a huge amount to be paying, which can actually hurt your budget in the long run. That said, it’s understandable that not everyone will be able to pay their entire credit card balance each month. Try to pay as much as you can reasonably afford and avoid making just the minimum payment. Your bank account and credit score will thank you.
The bottom line
Knowing how your credit card minimum payment is calculated is good knowledge, but it won’t necessarily help you. The important thing to understand is that if you make just the minimum payment, you’ll end up with some heavy interest charges. It’s always in your best interest to pay off your full balance each month.
Barry Choi is an award-winning personal finance and travel expert. He regularly appears on various shows in Canada and the U.S., where he talks about all things money and travel. His website - Money We Have - attracts thousands of visitors daily, looking for the latest stories on travel and money.